The United States is taking more steps to limit Chinese investment and capital raising in America. Many are claiming this marks the start of a fundamental capital divide between the two nations, part of a broader decoupling of their relationship. 

Whether or not this proves true is really not about any near-term restrictions. Instead, the real question is: what will become of the massive dollar capital flow from the U.S. to China? 

To be sure, Washington seems to be cordoning off some Chinese capital flows to the U.S. Total Chinese direct investment totaled a mere $200 million in the first quarter of 2020, about a tenth of the quarterly average last year. This was partly because of the spread of Covid-19, but also due to the stricter national-security restrictions that the U.S. is placing on Chinese investment.  

The U.S. is also moving to restrict capital inflows between the countries on two fronts in Washington. First, Sen. Marco Rubio has led a charge to stop federal-government retirement funds from investing in Chinese stocks. Perhaps more importantly, the U.S. Senate has passed the Holding Foreign Companies Accountable Act, a bill that would ban U.S. exchanges from listing any company from countries that prevent American regulators from examining audit papers, a group that includes China. (The House of Representatives has yet to vote on the measure.) 

At first blush, these actions appear to be signaling a death blow to Chinese investment and capital-raising in the United States. Yet, what we are likely seeing is a temporary hurdle rather than a permanent bar.  

Capital — accumulated money — is like water flowing down a hill. You can divert it but it often just ends up flowing elsewhere. Because China’s export-driven economy naturally accumulates dollars, those dollars need to flow somewhere.

Despite any U.S. roadblocks, Chinese businesses and individuals still have a keen desire to move capital out of greater China, and the U.S. remains an attractive destination for the likes of Chinese internet giant Tencent, which is negotiating to buy 10 percent of Warner Music as part of Warner’s planned initial public offering. That shows that capital will still flow to the U.S. from China, albeit to non-sensitive industries. 

Which isn’t to say Chinese capital will always be welcome, here or around the globe. Israel just rejected a bid by a Chinese company to build a desalination plant south of Tel Aviv — possibly because of national-security concerns or U.S. pressure. 

Back in Washington, if the delisting bill is enacted in its current form, China would have to deny access to a Chinese company’s audit papers for three years in a row for the company to get thrown off an exchange. So any actual delistings are years away. In the meantime, sizable Chinese companies will obtain dual listings in Hong Kong in order to migrate back if need be, but still tap the U.S. for capital. Indeed, just this past week Chinese grocery and delivery service Dada Nexus filed to raise $264 million in a Nasdaq IPO. 

While some U.S. actions will divert capital flows, U.S. investment in China remains open. Chinese investment will continue but into non-sensitive U.S. areas. The barriers are more of a diversion than a dam. 

But much of this is a sideshow. The real capital issue is the balance of trade between the two countries. Last year’s trade deficit was $346 billion — this year it is down sharply but will still likely be about $200 billion. The recent trade deal was designed to reduce this deficit further by mandating that China would purchase $200 billion worth of U.S. goods and services above 2017 levels.  

If capital investment by China is shut off, then China will have to invest more of its $3 trillion in reserves into other dollar-based assets. Much of this money — $1.08 trillion as of March — is now in U.S. Treasury Bonds. But China must continue to invest these dollars somewhere, and of course, the most likely place is the United States. 

And this is why the U.S. is pressing on a more-expansive trade deal. It wants to reduce China’s trade surplus so that China’s accumulation of dollars will slow or decline, rather than have to be reinvested in America.

The other area where the Chinese surplus can be reduced is through supply chain management. Taiwan Semiconductor Manufacturing Co.’s recent announcement of plans to build a new $12 billion plant in Arizona suggests a global reallocation of supply chains away from China is underway. The goal for the U.S. is not only to secure supplies but to stem investment in China. Indeed, while Chinese investment in the U.S. is down, that is not the case with U.S. investment in China.  

It all means that we are merely in the early innings of the battle over capital. While the Chinese and U.S. economies will have some measure of separation, the balance of payments ultimately must be equalized. In other words, the U.S. is going to have to find a way to repatriate all those China-held U.S. dollars.  

While near-term U.S. restrictions on Chinese investment and capital raising may redirect the flow for a while, it is the long term that matters. And in the long term, the U.S. is at the mercy of China’s dollar reserves. 

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